When starting a business, one might consider taking out a loan or using earnings from the company to fund expenses.
But what if the initial investment requires millions of dollars? And what if there is no product?
Many health industry-related startups conducting research on drugs, medical devices or new technologies rely , often solely , on venture capital dollars. In general, venture capital funds come from wealthy individuals or corporations that invest through venture capital firms. These investors often retain seats on the company’s board of directors, are granted stock, or both, in exchange for investing in the company.
Dependence on these investors is so great among biotech, medical device and other health care companies that for several years the health industry has received more money from venture capitalists than any other industry, according to the Pricewaterhouse & #173;Coopers Health Research Institute.
Each year, risk-taking investors plunge $5 billion to $6 billion into the health care industry, says the institute. And the amount has steadily increased since 1999, with the exception of 2000, when investors in life sciences and the dot-coms lost record amounts of money, the institute says.
In San Diego alone, venture capitalists invested about $296 million in health care industries in the second quarter. Biotechnology accounted for about 63 percent of all venture capital dollars invested in San Diego, according to the Health Research Institute.
The main alternative to venture capital dollars for startup companies, such as San Diego-based biotech Phenomix Corp., whose drugs are in the early stages of development, is to partner with a pharmaceutical company.
The downside to that, says Phenomix Chief Executive Officer Laura Shawver, is that royalties from discoveries would be greatly reduced.
“They will pretty much take it all,” said Shawver. “A company is lucky to retain 2 percent.”
Fortunately for Phenomix, which develops drugs to treat diseases such as diabetes and rheumatoid arthritis, it gained the fifth highest amount of money , $20 million , in the second quarter among San Diego biotechs that received venture capital.
Phenomix, founded in 2002, has 50 employees in San Diego and Canberra, Australia. Shawver said Phenomix is using the money raised in the second quarter to advance drugs toward approval from the Food and Drug Administration. She added that while the venture capitalists have a say in how the funds are used, the ones that invested in her company agreed with her business plan.
Phenomix is breaking the trend, say experts, because as the biotechnology industry matures, investors tend to look harder at companies that are closer to marketing a product.
While doing so may mean a faster return on investment, Dan Wood, who co-operates IngleWood Ventures, a San Diego-based venture capital firm, said the lack of funding for life science companies with products in early development is a “crisis.”
“These early stage companies are just not getting funded,” said Wood, who believes now is a good time to put the age-old adage “buy low, sell high” to use.
Shawver attributes her private company’s success in gaining favor from investors to a solid business plan. She would not disclose revenue figures.
Verus Pharmaceuticals, Inc., which received the third highest amount from venture capitalists in the second quarter, took in $28 million, or more than 11 percent of the total money invested by venture capitalists in San Diego, the Health Research Institute reports.
Verus CEO Robert Keith has said the company is using much of its funds for marketing its product, the first major competitor to the EpiPen, an epinephrine injector for severe allergic reactions.
Venture capitalists receive more than 40 business plans every month from startups looking for investors, said Jim Greenwood, the president of the Biotechnology Industry Organization, the Washington, D.C.-based international trade organization for life science companies.
Greenwood theorized that health industries still receive the majority of venture capitalist funds because “other industries may have reached their plateau.”
He said the constant yearning for innovation keeps interest high, and pointed to “the feel good factor.”
“This is the industry that’s going to transform the world most dramatically,” Greenwood said. “There’s an unlimited demand. Everyone wants to be healthy.”
Greg Vlahos, a partner in the life sciences and venture capital group at PricewaterhouseCoopers, said his firm planned to release third-quarter results for venture capital distributions on Oct. 24. He expected investment in the health industry to again soar, as it did in the second quarter, with a 47.6 percent increase from the first quarter.
Nationwide, investors took a risk on $1.77 billion in health care industries in the second quarter, amounting to nearly 30 percent of all investment , more than any other industry.
“There’s no reason to think this won’t continue,” Vlahos said, adding that the baby boomer generation is now mass-consuming health care and will continue to do so.
“The VCs invest on a 10-year horizon,” he said. “They’re thinking long-term.”